During the election campaign, LP will be cross-posting selected items from the Centre for Policy Development’s discussion of policy issues, Thinking Points. Readers may also be interested in the CPD’s collection of policy ideas and priorities for the next term, More Than Luck.
Ben Spies-Butcher writes:
Last year I reported on a proposal from Henry Ergas to the Liberal Party for a flat income tax. Ergas argued that it could improve work incentives and reduce complexity. I pointed out that it would also significantly reduce the progressivity, or fairness, of the tax system by giving large tax cuts to those at the top.
This week it appears the Coalition is back to the same game, saying it will look into a proposal from the Henry Tax Review. The proposal has been described as ‘almost’ a flat tax. But in reality it is a much more sensible reform than that proposed by Ergas, and if it were combined with other reforms from the Review, could be an improvement to the tax system.
What makes the Henry Review proposals different? The Review combines the best elements of a flat tax, with some modifications that substantially increase its equity. For virtually all full time workers, the tax rate will be the same –35 per cent. That rate kicks in just before the minimum wage, and goes right through to all but the top few percent of income earners.
So in this sense it is a flat tax, because workers do not find themselves bumped up into higher tax brackets as they get a pay rise or do some overtime. But the real concerns of a flat tax – that those on low incomes pay the same tax rate as high-income earners; and that the highest income earners get windfall tax gains, are reduced substantially.
The Review answers these concerns by including two other tax rates. The first is a generous tax-free threshold, going all the way up to $25,000 a year. This has two effects. First it reduces the interaction of the welfare are tax systems, and so reduces the poverty trap effect of losing benefits and paying tax as people enter the workforce.
Second, it means that a person’s average tax rate is closely related to their income. Someone earning $30,000 would only pay tax on the last $5,000. That would mean a total tax bill of $1,750, or 6 per cent of their income. Someone on $90,000 would pay $22,750, or 25 percent of their income. So the system would be progressive.
The Henry Review proposal also maintains the top tax rate for those on the highest incomes, over $180,000 per annum. This means high-income earners do not get the windfall gains of a single tax rate. That is also important for protecting the tax base as currently almost half our income tax revenues come from those earning over $150,000. But because very few people earn that much, keeping this top rate has virtually no effect on the vast bulk of workers and so still achieves greater simplicity.
In many ways, the Henry Review proposal is a logical response to the growing complexity of the income tax system. Governments have been cobbling together small-scale solutions to individual problems, but in turn simply creating new ones somewhere else in the system.
The tax threshold has been increased for very low-income earners, but then phased out, meaning even higher tax rates for those earning just a little more. There are also a series of offsets for groups like pensioners that would be better delivered as a higher benefit. Simplifying the system is a welcome move.
However, the other side of the Henry Review proposals is to broaden the tax base. In particular this means cracking down on fringe benefits and trusts, so that the same tax rates apply to all those earning the same income.
Interestingly the Coalition has yet to comment on this aspect of the proposal.
Full costings are not yet available, so some caution is needed. Simplifying the tax system by undermining the tax base and reducing funding for needed public services is not a useful reform. But it is good that our political leaders have started to engage with the Henry Review. Let us hope they also examine the reforms to housing, investment and tax concessions too.
From the 2007 Taxation Statistics, it can be calculated that there are approximately 8 million taxpayers with taxable incomes of $25,000 or over. Raising the tax threshold from $6,000 to $25,000 would give these people a basic tax cut of $2,850 (15% of the difference between the new and the old threshold). Multiplying this by 8 million (possibly more now) gives you a ballpark estimate of close to $23 billion as the annual cost of this measure. I would round this down to $20 billion as the new 35% rate claws back some of this, although there are about 2 million people below $25,000 who would get some tax cuts, just not as much as those at $25,000 or over.
So I think this is a long-term aspiration – to cut income tax revenue by $20 billion and balance the budget would require an increase in the GST to around 15% for example.
The proposal results in a pleasingly simplified – and still progressive – tax scale – its just that it is extremely expensive.
Put a tax of $40 tonne on greenhouse gases. Suppose they fall from 550 tonnes p.a. to 300 tonnes p.a. There’s half the cost of your income tax cuts paid for, and a good environmental result into the bargain.
“However, the other side of the Henry Review proposals is to broaden the tax base. In particular this means cracking down on fridge benefits and trusts, so that the same tax rates apply to all those earning the same income.”
bugger that,my fridge benefits are sacrosanct.
@3 – Fixed!
“So in this sense it is a flat tax…”
No it’s not, as you point out a bit further on, it’s progressive.
Having a constant marginal rate over a wide-ish income range does not imply a flat rate, if there’s a threshold so that the lowest incomes attract no (income) tax.
The GST is regressive, assuming that taxpayers’ spending is not proportional to their incomes (in which case it would be a flat tax).
As I’ve said elsewhere, the proposal bears a striking resemblance to the LDP 30/30 proposal (that’s almost 10 years old now, and needs updating, but still), only without the negative income tax. So much for us being fringe lunatics.
“Simplifying the tax system by undermining the tax base and reducing funding for needed public services is not a useful reform.”
Aargh? Why is there this pervasive assumption, which is really a false dichotomy? “Services not tax cuts” is a slogan on corflutes in my electorate, for example. Some services are needed, but it takes a brave soul to claim all government spending goes on “needed services”.